Moody's changed its outlook for Germany, the Netherlands and Luxembourg to "negative" from "stable", citing increased chances that Greece could leave the euro zone, which "would set off a chain of financial sector shocks".

Sentiment also worsened after a survey showed Germany's private sector shrank for a third straight month in July, suggesting Europe's largest economy may contract in the third quarter.

The euro zone's private sector also shrank for a sixth month in July. Financial shares were among the top decliners, with the insurance sector falling 1.2 per cent and the European banking index dropping 1 per cent.

The FTSEurofirst 300 index of top European shares was 0.21 per cent lower at 1,022.74 points. It fell 2.4 per cent to a three-week low in the previous session on concerns Spain could soon become the fourth euro zone member to request a full bailout.

Spanish five-year government bond yields rose above 10-year yields for the first time since June 2001, a sign that markets think the risk of a credit event has increased.

"Spain is a major area of concern from a political perspective. It's relatively a big economy in context of Europe and clearly has financing needs which at current levels of market bond yields look problematic," Ian Richards, head of equity strategy at Exane BNP Paribas, said.

"However, on periods of risk aversion when the market does have a little bit of a shocker, we need to be brave enough to recognise the underlying fundamentals in terms of valuations and earnings, which are very much attractive."

A big danger for the market is Spain, which might go for a full bailout. It's going to be a volatile month as the euro zone crisis lingers on. If we get some more negative news, shares could fall up to 10 per cent in the next two to three weeks, but they also have potential to rebound on a positive surprise.

The index's upward trend channel, in place since May, was broken and prices could move back towards 2,121 - a low in June. A breach of the level could open the door for a slide towards an eight-month low of 2,051 hit in early June, charts showed.

On the positive side, technology shares were the top gainers, with software rising 8 per cent after saying it continued to expect an EBIT margin of 23-24.5 per cent for 2012 after posting total revenue growth of 32 per cent in licensing sales in the second quarter.